## CONCLUSION ## Source details **Canonical URL:** [CONCLUSION](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1470.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1470.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1470.pdf.json) --- ### Introduction - Canadian banks entered the recent crisis that unfolded in 2007 with a solid funding base and high risk-based capital levels. - Banks generally avoided deterioration in residential mortgage underwriting standards seen in the United States and did not take large positions in U.S.-originated subprime mortgage securities, mortgage-back securities, or derivatives. - Credit quality of Canadian banks’ domestic loan and securities portfolios remained high throughout the crisis years; while the Canadian government provided a public guarantee program for bank debt during the crisis, no Canadian bank used these guarantees. - The paper focuses on institutional arrangements and market characteristics that helped Canada avoid many risky practices observed elsewhere rather than on macro enabling conditions. ### Summary of Findings - Success factors for the Canadian financial system include: - A strong economy and conservative federal fiscal stance that enabled credible government support and minimized pressure on asset quality. - A very effective and intrusive federal system of supervision and regulation practicing “close touch” supervision and emphasizing board and management accountability. - A collaborative financial regulatory infrastructure comprised of OSFI, the Bank of Canada (BOC), the Department of Finance (DOF), the Canada Deposit Insurance Corporation (CDIC), and the Financial Consumer Agency of Canada (FCAC); supervisory information, including institution-specific information, is shared among all members on a confidential basis. - A relatively concentrated financial system that is profitable, conservatively run, and has a strong reputation. - A government-backed mortgage finance system that fostered standard residential mortgage underwriting guidelines nationwide and provided a core base of profitable government-backed residential mortgage loans. - Government efforts to ensure healthy competition while discouraging competition based on low underwriting standards and underpricing of risk. ### Box 1 — Sustaining Canada’s Success (key observations and recommended focus areas) - Observations: - OSFI is growing in size, taking on more responsibilities, and undergoing a change in leadership. - New financial reforms are coming out of the FSB/G-20 that will affect banks’ profitability. - Large Canadian banks continue to expand outside of Canada. - Government support of the residential mortgage market through the CMHC helped stabilize this market during the GFC; the government recently has been imposing limits on the use of government-backed mortgage insurance. - Five areas recommended for increased attention: 1. Formalize processes and mandates, and increase transparency and reporting as federal regulatory scope and institution complexity expand. 2. Consider statutory formalization of OSFI’s operational independence by authorizing OSFI to issue its own enforceable regulations and making its prudential decisions virtually final. 3. Assess the sustainability of the continued dominance of the six large banks in retail finance as stricter regulatory policies, innovations by nonbank competitors, greater use of the Internet, and changing demographics may change the competitive balance. 4. Ensure provincially supervised credit unions that grow in systemic importance are subject to the same rigorous supervision and regulation as banks and that their depositors receive the same assurance of protection as CDIC-insured depositors. 5. Continue monitoring and adapting supervisory arrangements as market structure and institutions evolve. ### Quality of Supervision — Three Pillars - Assessment of supervisory quality starts with three essential pillars: supervisory mandate, independence, and resources. A. Statutory Mandate - OSFI’s statutory mandate is to protect the interests of depositors, policyholders, and creditors, and includes four elements: - Supervise federally regulated financial institutions to determine whether they are in sound financial condition and in compliance with their governing law and supervisory requirements; - Promptly advise institutions in the event there are material deficiencies and take, or require management or boards to take corrective measures expeditiously; - Establish a regulatory framework that promotes the adoption of policies and procedures to control and manage risk; and - Monitor and evaluate system-wide or sectoral issues that may impact institutions negatively. - OSFI’s mandate omits market conduct, ensuring public access to financial services, and development of the financial sector to avoid conflicts with prudential objectives. - A narrow safety-and-soundness mandate reduces role confusion but increases the premium on good communication and collaboration with market conduct supervisors. - Risk: future expansion of OSFI’s mandate could stretch resources and blur focus. B. Operational Independence - OSFI enjoys de facto supervisory independence despite being formally part of government; statutory approvals often involve both the Minister of Finance and the Superintendent of Financial Institutions. - OSFI lacks formal authority to issue its own regulations but uses regulatory “guidelines” viewed by industry as equivalent to regulations and indirectly enforceable under law. - Vulnerabilities of relying on guidelines: - Future senior staff changes at OSFI and DOF could curtail reliance on guidelines. - Private institutions might legally challenge guideline enforceability. - Recommendation: give OSFI full authority to make binding rules (e.g., issue its own enforceable rules) with full accountability to remove vulnerabilities and strengthen the federal financial regulatory system. C. Resources - OSFI is financed primarily through fees levied on federally regulated financial institutions rather than through general government revenue, providing fiscal independence and accountability to industry. - OSFI is subject to government-wide fiscal restraints (e.g., wage freezes) and administrative guidance of the Treasury Board of Canada; current guidance includes requirements to obtain Minister of Finance approval before spending on large events not directly related to OSFI’s core mandate. - These restrictions have not, for the most part, imposed practical constraints on OSFI’s operational independence or hindered its ability to obtain necessary resources. ### Supervisory capacity and staffing - Between 2007 and 2012, OSFI’s supervisory head count increased by approximately 50 percent. - OSFI had sufficient flexibility under the law to offer competitive compensation packages to mid-career and senior hires from the financial services industry. - Attracting and retaining financial sector specialists from industry and financial markets has been crucial to: - Staying current with emerging risks and market innovations. - Adding expertise and credibility to examination teams. - Improving the ability to question senior management at financial institutions. ### Principles-based supervision - OSFI has adopted a principles-based rather than rules-based approach to supervision. - Key attributes: - More adaptive to changing conditions. - Requires knowledgeable and experienced staff able to exercise judgment and focus on outcomes rather than strict textual compliance. - Senior management delegates significant responsibility to senior supervisors and backs them up when they make tough calls. - Industry acceptance is present in Canada, supporting supervisory discretion even without specific rule breaches. ### Intensity of supervision and board accountability - Supervisory philosophy: - Hold the board of directors and senior management accountable for safe and sound operation, legal compliance, and informing OSFI of problems. - Boards expected to understand and approve business objectives, significant strategic initiatives, and the internal control framework; be engaged in appointment/performance of oversight heads (audit, risk). - OSFI assesses board quality and effectiveness and may encourage improvements in weak boards. - Boards are expected to follow a “no surprises” approach by alerting OSFI as important issues arise. - Close-touch supervision: - Frequent contact at all levels, including boards; regular meetings with CROs, CFOs, and audit/risk committee board members. - Early and intensified intervention: - OSFI increases frequency and intensity of intervention when material risks or failure to follow up on issues are identified. - OSFI has an explicit and legal mandate for early intervention to protect depositors. ### Staging framework and escalation measures - OSFI places institutions into one of four stages of supervisory intensity and intrusiveness based on risk assessment (Stage 1 to Stage 4). - When an institution is “staged” OSFI: - Sends a supervisory letter formally notifying management, the board, and external auditor and requires remedial steps. - Meets with the bank to outline concerns and discuss remedial actions. - Increases monitoring/reporting frequency and conducts enhanced supervisory reviews. - May apply an assessment surcharge to cover additional supervision costs. - Might establish an ongoing presence at the bank and require external specialists (at the bank’s expense). - Interagency coordination: - OSFI keeps CDIC fully informed and provides updates to the Bank of Canada, the Department of Finance, and FCAC via the Financial Institutions Supervisory Committee (FISC). - CDIC maintains a “watch list” closely correlated with OSFI stages (particularly OSFI Stage 2) and can independently place members on it, send watch-list letters, conduct special examinations (and charge fees), and levy deposit insurance premium surcharges after consultation with OSFI. - CDIC’s involvement and FISC notifications are intended to convey seriousness to institution management and boards. ### Conservative supervisory stance and prudential standards - OSFI’s policy elements: - Intrusive supervision. - Requirement for meaningful and high quality capital. - Safeguards against risky behavior (e.g., lowered underwriting standards to gain market share). - Government actions complement OSFI: - Tightened guidelines for residential mortgage loan underwriting as problems emerged abroad. - Not allowing mergers among the large banks. - OSFI positioning relative to international standards: - Seeks to be ahead of the international community and more conservative than minimum international agreements. - Established higher capital requirements than required under Basel rules, emphasized capital quality and retained a formal leverage limit. - Canada was among the first advanced economies to adopt the Basel III capital standard and was the first country to adopt a Domestic Systemically Important Bank (D-SIB) framework, subjecting designated banks to a capital surcharge starting on January 1, 2016. - Outcomes: - Canadian banks entered the GFC in 2007 from a position of capital strength. - Higher prudential standards contributed to the strong international reputation of Canadian banks. - A perceived “halo effect” from OSFI’s reputation helped Canadian banks retain access to private institutional liquidity during the GFC. - Enforcement style: - Emphasizes moral suasion over heavy fines or litigation; will stage institutions when warranted with close monitoring and strict follow-up. ### Scope of OSFI supervision and provincial-level considerations - Federal supervision scope: - Under Canadian federal law, a bank is an entity incorporated and regulated at the federal level by OSFI; banks cannot be provincially incorporated. - The considerable majority of public deposits—over 90 percent—and most credit provision are associated with the federal banking system. - OSFI supervises banks, trust companies, the major insurance companies, and some pension funds, facilitating group-wide supervision given the universal banking model. - OSFI maintains working relationships with provincial securities and insurance supervisors to share examination information for bank affiliates outside the federal system. - Provincial deposit takers and credit unions: - Some provincially regulated depository institutions are systemically significant at the provincial level and are not routinely monitored by federal authorities. - Large provincial credit unions in Alberta, British Columbia, and Québec require provincial supervisors to have standalone capacity to effectively supervise them. - Deposit insurance at the provincial level lacks CDIC’s national diversity and federal backstop; provincial fiscal capacity to backstop provincially insured deposits is important. - Recommendation: large credit unions that pose systemic risk should be subject to the same rigorous supervision and regulation as other major depository institutions; more informal collaboration among provincial supervisors and between provincial supervisors and OSFI would be helpful. ### Cooperation, information sharing, and supervisory independence - Revised Basel Core Principles emphasize cooperation and information sharing across domestic and foreign authorities, typically including prudential and market conduct supervisors, central banks, and AML/CFT agencies. - Independence considerations: - Strong supervision requires a level of independence to protect supervisors from political pressure. - Harmful government interference in other jurisdictions has led to poorly resourced supervisory agencies and delays in prompt supervisory action. - Trade-offs: - Emphasis on supervisory independence can sometimes constrain information sharing and collaboration between supervisors and government, reinforced by statutory restrictions on sharing confidential information with finance ministries. ### Canada: Regulators Collaborate Closely with Government - Department of Finance (DOF) is one of the 5 federal financial sector regulatory agencies, with role to develop policy and legislative initiatives to ensure safety and soundness. - Canada has fostered a close informal working environment plus formal committees: Financial Institutions Supervisory Committee (FISC), Senior Advisory Committee (SAC), and the Board of the CDIC. - FISC: - Chaired by the OSFI Superintendent; includes BOC, DOF, FCAC, and CDIC. - Under the OSFI Act, every member is entitled to any information relating directly to supervision of financial institutions, even when such information is confidential supervisory data. - FISC members commit to maintaining confidentiality; meets at least quarterly and more often as needed; during the recent financial crisis there were weekly meetings and a free flow of information. - FISC is consultative; votes are not taken; accountability and decision-making with respect to supervisory decisions remain with OSFI. - SAC: - Same membership as FISC; chaired by the Deputy Minister of Finance. - Acts as a discussion forum for financial sector policy issues, including financial stability and systemic vulnerabilities. - CDIC Board of Directors: - Responsible for decisions and recommendations on use of resolution tools for federally-regulated member institutions. - Board includes SAC members plus six others drawn from the Canadian private sector. - CDIC is well staffed, can conduct special examinations, and acts as a second pair of eyes on health of depository institutions. - Effect: Senior members of OSFI, Bank of Canada, DOF, FCAC, and CDIC meet and work together regularly; relationships viewed as valuable. ### Benefits of Canadian Approach to Regulatory Collaboration - Positive outcomes: - Everyone is kept fully informed of issues and likely actions; entities without first-hand supervision experience (e.g., DOF) are kept up-to-date. - The five-year sunset and renewal cycle of major financial statutes for banking and insurance is managed by DOF; collaborative relationships ensure relevant parties can identify statutory provisions needing updating. - Senior industry representatives presume that when OSFI speaks or acts, the government has been fully informed and stands behind OSFI’s decision. - Crisis readiness: - Routine committee meetings and joint CDIC board membership reduce the possibility that government officials will unintentionally give conflicting or contradictory messages in a crisis. - Risk management: - Challenge: guard against DOF expanding its role and invading responsibilities of other agencies. - Mitigation: sensible division of responsibilities and clear mandates enforced by agency heads have prevented mission creep and encroachment. ### Non-Supervisory Factors - Performance during the crisis: - Only one of the six banks reported an annual loss (in 2008). - None appeared to be in danger of failure. - Government introduced a financial guarantee scheme to ensure banks had access to liquidity; none of the Canadian banks made use of the program. - All banks are now well-capitalized, reporting strong profits, have highly rated long-term debt, and four of the six appear on the Bloomberg list of the strongest and safest banks in the world. - Two additional contributing factors: structure of the financial industry and government actions to minimize risk to residential mortgage lenders. ### Structure and Conservatism of Canadian Bankers - Market structure and concentration: - Six largest Canadian banks (all designated by OSFI as D-SIBs) held 93 percent of total Canadian bank assets as of mid-2013 and 40 percent of total financial sector assets. - Foreign bank subsidiaries and branches held less than 5 percent of Canadian bank assets. - “Widely held” rule discourages acquisition of a major bank. - Life insurance sector: dominated by three Canadian companies; life and segregated funds sector represents some 16 percent of the Canadian financial sector; top three institutions held 76 percent of total Canadian life insurance assets in 2012. Property and casualty market represents only 2 percent of the financial sector market. - Business models and income: - Large Canadian banks fund primarily through deposits and focus on traditional personal and commercial lending in Canada. - Over 70 percent of profits for the top six banks in 2012 were derived from Canadian operations. - Banks compete on customer service and product features rather than price in many markets. - Mortgage insurance and capital treatment: - CMHC provides mortgage insurance and has assumed virtually all credit risk on insured mortgage loans subject to strict underwriting requirements. - Under Basel capital rules residential mortgage loans are assigned a low risk weight; debt guaranteed by the federal government is assigned a zero risk weight. - For the six largest banks, residential mortgage loans represent the majority of loans and single largest asset class; most of these loans carry mortgage insurance—resulting in relatively high risk-based capital ratios for a given level of leverage. - Capital and leverage metrics: - Canadian banks entered the GFC in 2007 with high risk-weighted capital levels relative to sample peers (Basel Tier 1 Capital Ratio; Last Observation: 2012Q4). - On an unweighted basis, Canadian banks’ asset to equity ratio (leverage) was much closer to that of U.K. and European banks; ratio higher than for U.S. banks (Last Observation: 2012Q4). - OSFI leverage policy: - Imposes an assets to capital multiple (ACM) test that limits leverage to 23 times capital although it expects banks to keep below 20 times capital as a rule (and sets much lower leverage ratios for smaller banks and new entrants). - OSFI modeling suggests the proposed new Basel leverage ratio of 3 percent (i.e. an assets to capital multiple of 33.3 times, but using a different definition for the denominator) is broadly equivalent to OSFI’s current leverage ratio limit. - CDIC increases contributions from banks which exceed 85 percent of their maximum leverage ratio. - Implications: - Higher leverage implies higher return on equity (ROE) for a given ROA; more leveraged banks can meet ROE targets with lower ROA. - Canadian banks may have been under less pressure to generate high income to meet ROE targets than U.S. banks. - Market structure and policy effects: - The system is frequently referred to as an oligopoly; requirement that ownership of big banks be widely held and government policy discouraging mergers have prevented acquisitions and takeovers. - Suggested “partnership between the government and a group of bankers” where regulatory policies reflect historical arrangements; in return banks accept OSFI’s conservative and intrusive supervision emphasizing higher capital, board and senior management accountability, and even-handed rule application. ### Mortgage exposure and why it has not posed a similar problem as in the U.S. - For all six large banks, residential mortgage loans represent the majority of their loans and their single largest asset class. - Five reasons for relative resilience of Canadian residential mortgage loans: 1. Canadian banks often conduct their own underwriting of mortgage loans rather than relying on independent brokers, giving banks more control over loan quality. 2. In most provinces, Canadian banks have full recourse to take legal action to recoup money from the homeowner if a foreclosed home is sold for less than the amount owed; exceptions: Alberta and Saskatchewan (Alberta does not always offer recourse based on vintage/nature of loan; Saskatchewan recourse only applies to re-financed mortgages). 3. CMHC has a Mortgage Loan Insurance program that provides 100 percent government-backed insurance to lenders; government also backs private mortgage insurers’ obligations to lenders subject to a deductible equal to 10 percent of the original principal amount of the mortgage loan. There are two active private mortgage insurers in Canada. 4. Since 2008, the federal government has reversed mid-2000s loosening and undertaken four rounds of measures to tighten eligibility requirements for mortgage insurance (e.g. tightening required mortgage loan amortization from 40 years down to 25 years). OSFI also issued underwriting guidelines for federally regulated financial institutions. 5. The Canadian legal system has a very efficient foreclosure system; lenders often gain access to collateral in less than a year, lowering the cost of defaults and mortgage finance costs. ### Conclusion: performance during the financial crisis - The Canadian banking system and the Canadian financial system managed the financial crisis very well. - Canada experienced liquidity pressures but prompt action by authorities and willingness of financial institutions to raise capital early facilitated a quick recovery. - Key contributing characteristics: - A high quality and conservative approach to federal bank supervision. - Close and effective working relationships among government agencies. - A relatively conservative and non-complex banking system. - A government housing policy that contributed to a very safe and liquid residential mortgage finance system. - Result: large Canadian banks are viewed both domestically and internationally as among the strongest banks in the world. ### Policy questions, additional steps, and lessons for other countries - Two overarching questions: - Are there additional steps Canada might take to strengthen their current system? - Are there lessons from the Canadian experience for other countries? - Additional steps: - The FSAP’s Financial System Stability Assessment and Box 1 list recommendations addressing current gaps and vulnerabilities (including vulnerability posed by large provincial depository institutions). - Lessons that stand out: 1. The benefits of “close-touch” supervision that holds management and boards fully accountable and becomes significantly more intense as weaknesses and vulnerabilities are identified. 2. The importance of strong capital positions of banks as the crisis unfolded, reflecting OSFI’s conservative approach to implementing international supervisory guidelines. 3. The value of close collaboration and full information sharing among the five Canadian regulatory authorities, including the Department of Finance, which enabled a prompt and effective response to the crisis. 4. The government’s efforts to ensure balanced competition—enough to ensure good quality services provided to the economy, but fettered to limit risky behavior intended to gain market share. *International Monetary Fund — CANADA (excerpt)._cr1470* ### CONCLUSION ___________________________________________________________________________________ 23 ### CONCLUSION ### Introduction - Canadian banks entered the recent crisis that unfolded in 2007 with a solid funding base and high risk-based capital levels. - Canadian banks generally avoided the deterioration in residential mortgage underwriting standards that occurred in the United States and did not take large positions in U.S.-originated subprime mortgage securities, mortgage-back securities, or derivatives. - The credit quality of Canadian banks’ domestic portfolio of loans and securities remained high throughout the crisis years; while the Canadian government provided a public guarantee program for bank debt during the crisis, no Canadian bank used these guarantees. - The paper focuses on institutional arrangements and market characteristics that helped Canada avoid many risky practices observed elsewhere rather than on macro enabling conditions. ### Summary of Findings - The success of the Canadian financial system in avoiding crises appears due to a combination of factors: - A strong economy and conservative federal fiscal stance that enabled credible government support and minimized pressure on asset quality. - A very effective and intrusive federal system of supervision and regulation that practices “close touch” supervision and emphasizes board and management accountability. - A well functioning and collaborative financial regulatory infrastructure comprised of OSFI, the Bank of Canada (BOC), the Department of Finance (DOF), the Canada Deposit Insurance Corporation (CDIC), and the Financial Consumer Agency of Canada (FCAC); supervisory information, including institution-specific information, is shared among all members on a confidential basis. - A relatively concentrated financial system that is profitable, conservatively run, and has a strong reputation. - A government-backed mortgage finance system that fostered standard residential mortgage underwriting guidelines nationwide and provided a core base of profitable government-backed residential mortgage loans. - Government efforts to ensure healthy competition while discouraging competition based on low underwriting standards and underpricing of risk. ### Background and Context - The global financial crisis (GFC) that began in 2007 exposed flaws in existing regulatory standards and prompted international reform efforts. - Not all developed countries were equally affected by the GFC; Canada is often cited as an example of resilience. - The IMF’s May 2010 Staff Discussion Note “The Making of Good Supervision: Learning to Say No” emphasized the importance of the “ability” to supervise—resources, authority, organization, and coordinated approach. - This note reviews the contribution of supervision to Canadian banks’ strong performance, focusing on federal supervision by OSFI, while acknowledging the role of cultural conservatism and a concentrated banking structure. - Caveats: - The note reflects current practice at OSFI, some of which may have been enhanced since the onset of the crisis. - Metrics related to supervisory effectiveness remain a work in progress; there is no single guaranteed framework for success. - Historical note: in 2006-2007 some Canadian banks suffered losses in commodity trading and write-downs of collateralized debt obligations and mortgage-backed securities; the non-bank backed asset-backed commercial paper market required restructuring. ### Box 1 — Sustaining Canada’s Success (key observations and recommended focus areas) - Observations: - OSFI is growing in size, taking on more responsibilities, and undergoing a change in leadership. - New financial reforms are coming out of the FSB/G-20 that will affect banks’ profitability. - Large Canadian banks continue to expand outside of Canada. - Government support of the residential mortgage market through the CMHC helped stabilize this market during the GFC; the government recently has been imposing limits on the use of government-backed mortgage insurance. - Five areas recommended for increased attention: 1. Formalize processes and mandates, and increase transparency and reporting as federal regulatory scope and institution complexity expand. 2. Consider statutory formalization of OSFI’s operational independence by authorizing OSFI to issue its own enforceable regulations and making its prudential decisions virtually final. 3. Assess the sustainability of the continued dominance of the six large banks in retail finance as stricter regulatory policies, innovations by nonbank competitors, greater use of the Internet, and changing demographics may change the competitive balance. 4. Ensure provincially supervised credit unions that grow in systemic importance are subject to the same rigorous supervision and regulation as banks and that their depositors receive the same assurance of protection as CDIC-insured depositors. 5. (Implicit across Box 1) Continue monitoring and adapting supervisory arrangements as market structure and institutions evolve. ### Quality of Supervision — Three Pillars - Any assessment of supervisory quality starts with three essential pillars: supervisory mandate, independence, and resources. A. Statutory Mandate - OSFI’s statutory mandate is to protect the interests of depositors, policyholders, and creditors, and includes four elements: - Supervise federally regulated financial institutions to determine whether they are in sound financial condition and in compliance with their governing law and supervisory requirements; - Promptly advise institutions in the event there are material deficiencies and take, or require management or boards to take corrective measures expeditiously; - Establish a regulatory framework that promotes the adoption of policies and procedures to control and manage risk; and - Monitor and evaluate system-wide or sectoral issues that may impact institutions negatively. - OSFI’s mandate deliberately omits market conduct, ensuring public access to financial services, and development of the financial sector to avoid conflicts with prudential objectives. - A narrow safety-and-soundness mandate reduces role confusion but increases the premium on good communication and collaboration with market conduct supervisors. - Risk identified: a future expansion of OSFI’s mandate could stretch resources and blur focus. B. Operational Independence - OSFI enjoys de facto supervisory independence despite being formally part of government; statutory approvals often involve both the Minister of Finance and the Superintendent of Financial Institutions, with the Minister able to exercise discretion in certain cases. - OSFI lacks formal authority to issue its own regulations but uses regulatory “guidelines” that it can issue promptly; guidelines are viewed by industry as equivalent to regulations and are indirectly enforceable under law. - Vulnerabilities of relying on guidelines: - Future senior staff changes at OSFI and DOF could curtail reliance on guidelines. - Private institutions might legally challenge guideline enforceability. - Recommendation: giving OSFI full authority to make binding rules (e.g., ability to issue its own enforceable rules) with full accountability would remove vulnerabilities and strengthen the federal financial regulatory system. C. Resources - OSFI is financed primarily through fees levied on federally regulated financial institutions rather than through general government revenue, providing fiscal independence and accountability to industry. - OSFI is subject to government-wide fiscal restraints (e.g., wage freezes) and administrative guidance of the Treasury Board of Canada; current guidance includes requirements to obtain Minister of Finance approval before spending on large events not directly related to OSFI’s core mandate. - These restrictions have not, for the most part, imposed practical constraints on OSFI’s operational independence or hindered its ability to obtain necessary resources. *Source: CONCLUSION, _cr1470 (IMF).* ### 22. Having observed the causes and the consequences of the recent crisis, OSFI has been ### _cr1470 - 22. Having observed the causes and the consequences of the recent crisis, OSFI has been ### Supervisory capacity and staffing - Between 2007 and 2012, OSFI’s supervisory head count increased by approximately 50 percent. - OSFI had sufficient flexibility under the law to offer competitive compensation packages to mid-career and senior hires from the financial services industry. - Attracting and retaining financial sector specialists from industry and financial markets has been crucial to: - Staying current with emerging risks and market innovations. - Adding expertise and credibility to examination teams. - Improving the ability to question senior management at financial institutions. ### Principles-based supervision - OSFI has adopted a principles-based rather than rules-based approach to supervision. - Key attributes of OSFI’s approach: - Principles-based supervision is more adaptive to changing conditions. - Successful implementation requires knowledgeable and experienced staff able to exercise judgment and focus on outcomes rather than strict textual compliance. - Senior management delegates significant responsibility to senior supervisors and backs them up when they make tough calls. - Industry acceptance requirement: - A principles-based system requires regulated entities to accept supervisory discretion even in the absence of specific rules or laws that have been violated. - This acceptance appears to be present in Canada. - Outcome: - OSFI anticipated some problems encountered by banks in other countries, enhancing OSFI’s credibility with industry and government. ### Intensity of supervision and board accountability - Supervisory philosophy: - Hold the board of directors and senior management accountable for safe and sound operation, legal compliance, and informing OSFI of problems. - Boards are expected to understand and approve business objectives, significant strategic initiatives, and the internal control framework, and to be engaged in appointment/performance of oversight heads (audit, risk). - OSFI assesses board quality and effectiveness and may encourage improvements in weak boards. - Boards are expected to follow a “no surprises” approach by alerting OSFI as important issues arise. - Close-touch supervision: - OSFI practices “close-touch” supervision with frequent contact at all levels, including boards, and regular meetings with CROs, CFOs, and audit/risk committee board members. - This approach has produced very positive results. - Early and intensified intervention: - OSFI increases frequency and intensity of intervention when material risks or failure to follow up on issues are identified. - OSFI has an explicit and legal mandate for early intervention; objective is to engage at an early stage to protect depositors. ### Staging framework and escalation measures - OSFI uses a formal system of placing institutions into one of four stages of supervisory intensity and intrusiveness based on risk assessment. - Stages range from Stage 1 (intensive supervision) to Stage 4 (which might lead to OSFI taking control and possibly applying to the Attorney General of Canada for a “winding-up” order). - When an institution is “staged”: - OSFI sends a supervisory letter formally notifying management, the board, and external auditor and requires remedial steps. - OSFI meets with the bank to outline concerns and discuss remedial actions. - OSFI increases monitoring/reporting frequency and conducts enhanced supervisory reviews. - OSFI may apply an assessment surcharge to cover additional supervision costs. - OSFI might establish an ongoing presence at the bank and require external specialists (at the bank’s expense). - Interagency coordination: - OSFI keeps CDIC fully informed and provides updates to the Bank of Canada, the Department of Finance, and FCAC via the Financial Institutions Supervisory Committee (FISC). - CDIC maintains a “watch list” closely correlated with OSFI stages (particularly OSFI Stage 2) and can independently place members on it, send watch-list letters, conduct special examinations (and charge fees), and levy deposit insurance premium surcharges after consultation with OSFI. - CDIC’s involvement and FISC notifications are intended to convey seriousness to institution management and boards. ### Conservative supervisory stance and prudential standards - OSFI’s policy elements: - Intrusive supervision. - Requirement for meaningful and high quality capital. - Safeguards against risky behavior (e.g., lowered underwriting standards to gain market share). - Government actions complement OSFI: - Tightened guidelines for residential mortgage loan underwriting as problems emerged abroad. - Not allowing mergers among the large banks. - OSFI’s positioning relative to international standards: - OSFI seeks to be ahead of the international community and more conservative than minimum international agreements. - OSFI established higher capital requirements than required under Basel rules, emphasized capital quality and retained a formal leverage limit. - Canada was among the first advanced economies to adopt the Basel III capital standard and was the first country to adopt a Domestic Systemically Important Bank (D-SIB) framework, subjecting designated banks to a capital surcharge starting on January 1, 2016. - Outcomes: - Canadian banks entered the GFC in 2007 from a position of capital strength. - Higher prudential standards contributed to the strong international reputation of Canadian banks for being well managed and well supervised. - Canadian banks have often been included on international lists of the safest banks in the world. - A perceived “halo effect” from OSFI’s reputation helped Canadian banks retain access to private institutional liquidity during the GFC. - Enforcement style: - OSFI emphasizes moral suasion over heavy fines or litigation. - OSFI typically seeks to work with management initially but will stage institutions when warranted; close monitoring and strict follow-up are required when remedies are pursued. ### Scope of OSFI supervision and provincial-level considerations - Federal supervision scope: - Under Canadian federal law, a bank is an entity incorporated and regulated at the federal level by OSFI; banks cannot be provincially incorporated. - The considerable majority of public deposits—over 90 percent—and most credit provision are associated with the federal banking system. - OSFI supervises banks, trust companies, the major insurance companies, and some pension funds, facilitating group-wide supervision given the universal banking model with affiliates across retail, commercial, investment banking, wealth management, and insurance. - OSFI maintains good working relationships with provincial securities and insurance supervisors to share examination information for bank affiliates outside the federal system. - Provincial deposit takers and credit unions: - Some provincially regulated depository institutions are systemically significant at the provincial level and are not routinely monitored by federal authorities. - Large provincial credit unions in Alberta, British Columbia, and Québec require provincial supervisors to have standalone capacity to effectively supervise them. - Large credit unions with multiple business lines can be complex and require specialized supervision similar to large banks; dispersion of supervisory talent across provinces can make it challenging for a single provincial supervisor to acquire necessary breadth and depth. - Deposit insurance at the provincial level lacks CDIC’s national diversity and federal backstop; provincial fiscal capacity to backstop provincially insured deposits is important. - Financial stability considerations suggest large credit unions that pose systemic risk should be subject to the same rigorous supervision and regulation as other major depository institutions; more informal collaboration among provincial supervisors and between provincial supervisors and OSFI (e.g., performance comparisons, stress tests) would be helpful. ### Cooperation, information sharing, and supervisory independence - Revised Basel Core Principles emphasize cooperation and information sharing across domestic and foreign authorities, typically including prudential and market conduct supervisors, central banks, and AML/CFT agencies; they do not usually include a representative from government. - Independence considerations: - Strong supervision requires a level of independence to protect supervisors from political pressure. - Harmful government interference in other jurisdictions has led to poorly resourced supervisory agencies, constraints on adopting conservative regulations, and delays in prompt supervisory action. - FSAP missions have been critical of formal government roles in supervisory leadership or potential interference in licensing, regulation, or supervisory decision-making. - Trade-offs: - Emphasis on supervisory independence can sometimes constrain information sharing and collaboration between supervisors and government, reinforced by statutory restrictions on sharing confidential information with finance ministries and minimal consultation on major supervisory decisions. *Italic source: _cr1470 - 22. Having observed the causes and the consequences of the recent crisis, OSFI has been* ### 44. The presumption is that by not sharing such information, ex ante, the possibility of ### 44. The presumption is that by not sharing such information, ex ante, the possibility of ### B. Canada Regulators Collaborate Closely with Government - Department of Finance (DOF) describes itself as one of the 5 federal financial sector regulatory agencies, along with OSFI, the Bank of Canada, the Canada Deposit Insurance Corporation (CDIC), and the Financial Consumer Agency of Canada (FCAC). DOF’s role: develop policy and legislative initiatives to ensure the safety and soundness of the financial sector. - Canada has fostered a close informal working environment plus a set of formal committees and an interlocking board governing the deposit insurance agency. - Key formal fora to ensure cooperation and coordination: Financial Institutions Supervisory Committee (FISC), Senior Advisory Committee (SAC), and the Board of the CDIC. - FISC: - Chaired by the OSFI Superintendent; includes BOC, DOF, FCAC, and CDIC. - Under the OSFI Act, every member is entitled to any information relating directly to supervision of financial institutions, bank holding companies or insurance holding companies, even when such information is confidential supervisory data. - FISC members commit to maintaining confidentiality of such information. - FISC meets at least quarterly and more often as needed; during the recent financial crisis there were weekly meetings and a free flow of information. - FISC is consultative; votes are not taken; accountability and decision-making with respect to supervisory decisions remain with OSFI. - SAC: - Same membership as FISC; chaired by the Deputy Minister of Finance. - Acts as a discussion forum for financial sector policy issues, including financial stability and systemic vulnerabilities. - Invites other government agencies when appropriate; members remain responsible for formulating policies consistent with their mandates. - SAC is not a decision-making body. - CDIC Board of Directors: - Responsible for making decisions and recommendations on use of resolution tools for federally-regulated member institutions. - Board includes SAC members plus six others drawn from the Canadian private sector, including the Chair. - CDIC is well staffed, can conduct special examinations, and acts as a second pair of eyes on health of depository institutions. - Effect: Senior members of OSFI, Bank of Canada, DOF, FCAC, and CDIC meet and work together regularly; relationships viewed as valuable (“people are willing to invest in these relationships.”). ### C. Benefits of Canadian Approach to Regulatory Collaboration - Three positive outcomes identified: - Everyone is kept fully informed of issues and likely actions; entities without first-hand supervision experience (e.g., DOF) are kept up-to-date. - The five-year sunset and renewal cycle of major financial statutes for banking and insurance is managed by DOF; collaborative relationships ensure relevant parties can identify statutory provisions needing updating. - Senior industry representatives presume that when OSFI speaks or acts, the government has been fully informed and stands behind OSFI’s decision; it is not common for industry or major banks to seek Minister of Finance/DOF intervention to override OSFI. - Crisis readiness: - Routine committee meetings and joint CDIC board membership reduce the possibility that government officials will unintentionally give conflicting or contradictory messages in a crisis. - Risk management of close DOF partnership: - Challenge: guard against DOF expanding its role and invading responsibilities of other agencies. - Mitigation: sensible division of responsibilities, clear mandates enforced by agency heads have prevented mission creep and encroachment. ### Non-Supervisory Factors - Canadian banks managed the global financial crisis well: - Only one of the six banks reported an annual loss (in 2008). - None appeared to be in danger of failure. - Government introduced a financial guarantee scheme to ensure banks had access to liquidity; none of the Canadian banks made use of the program. - All banks are now well-capitalized, reporting strong profits, have highly rated long-term debt, and four of the six appear on the Bloomberg list of the strongest and safest banks in the world. - Two additional factors contributing to absence of financial crises: structure of the financial industry and government actions to minimize risk to residential mortgage lenders. ### A. Structure and Conservatism of Canadian Bankers - Market structure and concentration: - Six largest Canadian banks (all designated by OSFI as D-SIBs) dominated system: held 93 percent of total Canadian bank assets as of mid-2013 and 40 percent of total financial sector assets. - Foreign bank subsidiaries and branches held less than 5 percent of Canadian bank assets. - “Widely held” rule discourages acquisition of a major bank. - Life insurance sector: dominated by three Canadian companies; life and segregated funds sector represents some 16 percent of the Canadian financial sector; top three institutions held 76 percent of total Canadian life insurance assets in 2012. Property and casualty market represents only 2 percent of the financial sector market. - Business models and income: - Large Canadian banks have conservative models: funding primarily through deposits; lending focuses on traditional personal and commercial sectors in Canada. - Universal bank model pursued, but over 70 percent of profits for the top six banks in 2012 were derived from Canadian operations. - Banks compete on customer service and product features rather than price in many markets. - Cross-border operations provide diversification but introduce risks; OSFI has established strong working relationships and information sharing arrangements with relevant foreign supervisors. - Mortgage insurance and capital treatment: - CMHC (Crown Corporation) provides mortgage insurance; CMHC has assumed virtually all credit risk on insured mortgage loans subject to strict underwriting requirements; interest rate on loans resets every five years. - Under Basel capital rules: residential mortgage loans are assigned a low risk weight; debt guaranteed by full faith and credit of the federal government is assigned a zero risk weight. - For the six largest banks, residential mortgage loans represent the majority of loans and single largest asset class; most of these loans carry mortgage insurance—result: relatively high risk-based capital ratio for a given level of leverage compared to banks holding riskier assets. - Capital and leverage metrics (figures referenced): - Canadian banks entered the GFC in 2007 with high risk-weighted capital levels relative to sample peers (Basel Tier 1 Capital Ratio; Last Observation: 2012Q4). - On an unweighted basis, Canadian banks’ asset to equity ratio (leverage) was much closer to that of U.K. and European banks; ratio higher than for U.S. banks (Last Observation: 2012Q4). - OSFI leverage policy: - OSFI imposes an assets to capital multiple (ACM) test that limits leverage to 23 times capital although it expects banks to keep below 20 times capital as a rule (and sets much lower leverage ratios for smaller banks and new entrants). - OSFI modeling suggests the proposed new Basel leverage ratio of 3 percent (i.e. an assets to capital multiple of 33.3 times, but using a different definition for the denominator) is broadly equivalent to OSFI’s current leverage ratio limit. - CDIC increases contributions from banks which exceed 85 percent of their maximum leverage ratio. - Implications for profitability and risk-taking: - Higher leverage implies higher return on equity (ROE) for a given ROA; more leveraged banks can meet ROE targets with lower ROA (take less risk). - Canadian banks may have been under less pressure to generate high income to meet ROE targets than U.S. banks. - Market structure and policy effects: - The banking system is frequently referred to as an oligopoly; requirement that ownership of big banks be widely held and government policy discouraging mergers have prevented acquisitions and takeovers. - Policy effects: reduced takeover threat provides protection to banks’ management; competition exists domestically among large banks. - Historical stability: Royal Bank of Canada largest among six since at least World War II; National Bank of Canada the smallest of the large banks. - Suggested “partnership between the government and a group of bankers” where regulatory policies reflect historical arrangements; in return the banks accept OSFI’s conservative and intrusive supervision emphasizing higher capital, board and senior management accountability, and even-handed rule application. *Source: IMF staff report excerpt (CR/1470) contained in the supplied PDF content.* ### 74. Another factor in the strong performance of Canadian banks’ may be their large ### Another factor in the strong performance of Canadian banks’ may be their large holding of Canadian residential mortgage loans. ### Mortgage exposure and why it has not posed a similar problem as in the U.S. - For all of the six large banks, residential mortgage loans represent the majority of their loans and their single largest asset class. - Five reasons identified for the relative resilience of Canadian residential mortgage loans: - First: Canadian banks often conduct their own underwriting of mortgage loans rather than relying on independent brokers. This gives the banks more control over the quality of the loans and minimizes the issue that arose in the U.S. of mortgage brokers being compensated on the volume of loans generated with inadequate attention paid to the quality of underwriting. - Second: In most provinces, Canadian banks have full recourse to take legal action to recoup money from the homeowner if a foreclosed home is sold for less than the amount owed on the mortgage.25 This avoids the phenomenon, again seen in the United States, of higher risk loans being made where there is no recourse to the other assets of borrowers in the event of default. - Exceptions: The Provinces of Alberta and Saskatchewan. The Province of Alberta does not always offer recourse to lenders, based on the vintage and nature of the loan. In Saskatchewan, recourse only applies to re-financed mortgages. (See “Canadian Mortgage Market Primer”, in Market Musings, TD Securities, July 5, 2010.) - Third: The Canada Mortgage and Housing Corporation (CMHC) has a Mortgage Loan Insurance program that provides 100 percent government-backed insurance to lenders.26 - The Government also backs private mortgage insurers’ obligations to lenders subject to a deductible equal to 10 percent of the original principal amount of the mortgage loan. In the event of a private mortgage insurer’s winding-up, the Government would honor lender claims for insured mortgages in default, subject to the 10 percent deductible and any applicable liquidation proceeds. There are two active private mortgage insurers in Canada. - Fourth: Since 2008, the federal government has reversed the loosening that occurred in the mid-2000’s and undertaken four rounds of measures to tighten the eligibility requirements for mortgage insurance (e.g. tightening required mortgage loan amortization from 40 years down to 25 years). OSFI also issued underwriting guidelines for federally regulated financial institutions. These efforts reduced the ability of more aggressive lenders from seeking to expand their mortgage business by adoption of soft underwriting terms. - Fifth: The Canadian legal system has a very efficient foreclosure system. When a borrower defaults on a loan, the bank is able to gain access to the collateral, often in less than a year. The ability of the lender to resolve default situations in a timely and cost effective manner lowers the cost of defaults and hence, makes the cost of mortgage finance less expensive. ### Conclusion: performance during the financial crisis - The Canadian banking system and the Canadian financial system managed the financial crisis very well. - Canada experienced liquidity pressures but prompt action by authorities and the willingness of financial institutions to raise capital early (despite steep discounts in their share prices) facilitated a quick recovery. - Key characteristics contributing to success: - A high quality and conservative approach to federal bank supervision. - Close and effective working relationships among government agencies. - A relatively conservative and non-complex banking system. - A government housing policy that contributed to a very safe and liquid residential mortgage finance system. - Result: large Canadian banks are viewed both domestically and internationally as among the strongest banks in the world. ### Contributory factors and supervisory stance - Contributory factors to favorable outcomes included: - The effectiveness of OSFI. - Close cooperation among government regulatory authorities. - The concentrated and conservative nature of the Canadian banking sector. - Support of the residential mortgage market provided through the CMHC.27 - High risk-based capital levels held by Canadian banks reflected: - OSFI’s conservative interpretation of the Basel capital rules. - The conservative nature of Canadian banks. - From the perspective of financial stability, supervisors, the central bank, and government were proactive and effective; Canadian banks were perceived as having strong and robust balance sheets. ### Policy questions, additional steps, and lessons for other countries - Two overarching questions: - Are there additional steps Canada might take to strengthen their current system? - Are there lessons from the Canadian experience for other countries? - Additional Steps: - The FSAP’s Financial System Stability Assessment and Box 1 at the beginning of the note list recommendations addressing current gaps and vulnerabilities (including vulnerability posed by large provincial depository institutions). - Lessons that stand out: - (1) The benefits of “close-touch” supervision that holds management and boards fully accountable and becomes significantly more intense as weaknesses and vulnerabilities are identified. - (2) The importance of strong capital positions of banks as the crisis unfolded, reflecting OSFI’s conservative approach to implementing international supervisory guidelines. - (3) The value of close collaboration and full information sharing among the five Canadian regulatory authorities, including the Department of Finance, which enabled a prompt and effective response to the crisis. - (4) The government’s efforts to ensure balanced competition—enough to ensure good quality services provided to the economy, but fettered to limit risky behavior intended to gain market share. *International Monetary Fund — CANADA (excerpt)._cr1470* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1470.pdf_